Rivals and partners

Are India and China coming together?

AN UNSTATED assumption of this survey has been that India and China are rivals. That is certainly the way it seems from India. In economic growth, global influence and military might, India cannot help but measure itself against its neighbour. Ever since China's rout of India in a brief but bloody war in 1962, this comparison has been tinged with a sense of injustice, humiliation and suspicion.

But this is a rather one-sided competition. India desperately wants the international standing and respect that China already enjoys. In particular, it wants this status symbolised, as China's is, through a permanent, veto-wielding seat on the United Nations Security Council. If China measures itself against any country, however, it is America.

Its relationship with India, moreover, is changing: diplomatic relations are better than at any time since 1962, and trade is booming. The two civilisations have cultural, religious and trading links dating back 2,500 years. They are not doomed to be enemies. So is this the dawn of a new era of partnership and co-operation, the creation, as some suggest, of an “India-China nexus” that will change the world?

There are strong grounds for scepticism. First, Indian suspicions of China run deep, and the disagreement that caused the war still looms large. Usually labelled a “border dispute”, it is not some minor cartographic tiff. India claims an area of Chinese-controlled territory in Ladakh, Kashmir, that is the size of Switzerland. China's claim to what is now the Indian state of Arunachal Pradesh covers an area three times bigger (see map). Since 1988, working groups have been meeting to discuss the dispute. Their main aim has been not so much to reach agreement but to shelve the issue, allowing relations to improve in other areas.

New impetus was injected, however, when Atal Behari Vajpayee, then India's prime minister, visited China in 2003. Talks on the border dispute were moved to a much higher level. A settlement involving swapping claims and making some minor border adjustments still seems remote, because of the political difficulty of selling such a deal in India. But it is no longer inconceivable.

Beijing University's Jia Qingguo argues that a renewed Chinese interest in India was in part provoked by America's attempts under the Clinton administration, and, until September 11th 2001, under George Bush as well, to “use India to contain China”. Kishore Mahbubani, a Singaporean former diplomat who now heads the Lee Kwan Yew School for Public Policy, makes a similar point: that China is “buying political insurance now” through all its neighbours. It knows America will be alarmed by its emergence as a great power and, far-sightedly, wants those neighbours to share in its prosperity.

China's “all-weather” friendship with Pakistan has always complicated relations with India, though China has long stopped voicing explicit support for Pakistan's stance on Kashmir, and appears to have played an important role in 2003 in persuading it to start serious peace talks with India. But some Indian analysts still point to China's “strategic encirclement” of India—ie, its attempts to make friends with all of India's neighbours, from Sri Lanka to Myanmar. When India became a declared nuclear power in 1998, Mr Vajpayee wrote to President Clinton to explain his reasons for the move, citing “an overt nuclear weapons state on our borders, a state which committed armed aggression against India in 1962”. China, which had reacted calmly to India's bomb, was peeved at being used to justify it.

Chinese officials implied that, if India wanted an arms race, China was ready. Such sabre-rattling has died down since then. But as China's economy grows, it will probably want an army to match its economic might. India may find it hard to believe that Chinese intentions are benign. One Chinese scholar sees similarities between Indian attitudes to China and Chinese attitudes to Japan. The animosity in Sino-Japanese relations is far more deep-seated, but there is the same mixture of historical grudge and present envy.

India and China may also find themselves in competition for resources, especially energy. In the period up to 2020, Chinese demand for oil is expected to grow by almost as much as America's in absolute terms. India is also dependent on imported hydrocarbons, and is hungrily seeking long-term supplies of oil and gas. In one sign that the two countries might co-operate as well as compete, India in January announced it had acquired a 20% share in the development of Iran's biggest onshore oilfield, which is operated and 50% owned by Sinopec, China's state-owned oil company.

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As relations have improved, there has been much talk about the “complementarity” of the two economies. With Indian software and Chinese hardware, goes the refrain, the world will be at our feet. Looked at from the perspective of American multinationals, shifting some of their manufacturing to China and some of their back-office processes to India, this makes some sense. But its application to direct Sino-Indian economic exchanges seems limited for now.

Fast as they are growing, these are still small. The two countries' bilateral trade, in which India enjoys a surplus, has been growing by leaps and bounds, to reach $13 billion in 2004. But that is just 1% of China's global trade, though 9% of India's. There are only seven direct flights a week between India and China, compared with, for example, six a day between Shanghai and Bangkok alone. In 2003, of the 11.4m tourists who visited China, just 211,000 were Indian; and only 21,000 Chinese visited India.

Investment flows are still small. Huawei, a Chinese telecoms-equipment firm, employs several hundred software engineers in Bangalore. Chinese white-goods makers such as Hai'er are fighting for market share in India. In the other direction, Indian software firms are setting up in China, and some firms are manufacturing there.

Indian companies' interest in China (like that of many multinationals) remains focused mainly on export markets, or on the foreign sector within China. Tata Consultancy Services, for example, India's biggest software firm, has a development centre in Hangzhou where it employs some 200 people. Its regional director, Girija Pande, says it was drawn to China by the needs of its multinational clients. Only a small proportion of its work there is for Chinese customers.

Similarly, in manufacturing, Orind Refractories, an Indian firm that has been making refractory bricks for steel furnaces in China's north-eastern Liaoning province for ten years, exports 98% of its output, despite a huge demand for the bricks in China itself. Competing with local firms is hard, and getting paid is even harder.

First Eastern, a Hong Kong-based private-equity firm that has invested in 80 projects in China, is planning to launch a $200m fund to invest in Indian ventures in China, Chinese projects in India and joint ventures in third countries. Victor Chu, First Eastern's boss, says the aim is “to realise the largest potential synergy” in Asia. He sees opportunities in, for example, pharmaceuticals, and Chinese tourism to India. One Indian pharmaceutical firm, Ranbaxy, has been manufacturing in China since 1995, and outbound tourism is growing fast.

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From such a low base, it would be surprising if two-way trade and investment flows did not increase rapidly. But China is becoming so integrated with the rest of the global economy that it is hard to see how its business with India alone will make a huge difference.

Soft and hard

India and China will have what Mr Chu calls a “competitive partnership”. In India, the Chinese bogey is constantly invoked as the biggest potential threat to India's lead in exports of IT services and outsourcing. China, it is argued, is only a few years behind in producing similar numbers of software engineers and of English-speaking graduates. Such is its clout in the global economy that it will prise India's one undisputed niche away from it.

Useful though such warnings may be in keeping Indian firms on their toes, they seem a bit far-fetched. Some outsourcing operations, such as call-centres, are already setting up in China. GE Capital International Services, an India-based back-office-services firm set up by General Electric, is one of several firms with operations in Dalian in China's north-east, where it employs more than 1,000 people. From there, it can provide services both to China and to Japan and Korea.

In those markets, Indian IT-services firms will certainly find themselves at a disadvantage. But in services requiring fluent English-speakers, it is likely to retain its lead for a long time yet. The same applies to software. The Chinese software industry is fragmented, focused on its domestic market and inexperienced in dealing with the complex collaborative development projects in which Indian firms excel.

The next China?

The more interesting and important question is whether India can compete with—or at least emulate—China in labour-intensive manufacturing for export. There is no other way that Indian economic growth can be raised consistently to match that achieved in China in the past two decades. Some Indian manufacturers remain in awe of China's ability to grab and dominate a market. Rahul Gupta, managing director of Phoenix Lamps near Delhi, for example, says that in one of his firm's products, compact fluorescent lamps, China has 65% of the global market. China's role as the global economy's manufacturing hub is unstoppable, and India has “missed the boat”.

Phoenix refuses to compete head-on with Chinese lampmakers. Their prices are unbeatable. Mr Gupta, and many others, attribute this to a variety of open and hidden subsidies: an undervalued exchange rate, cheap credit with few penalties for default, underpriced land, unpaid suppliers' bills, export subsidies and so on. Phoenix's response has been to move upmarket and compete on quality in less price-sensitive markets.

That has been the story for many of India's successful exporters. But is the battle for the bargain basement really lost? Orind's boss, Rajeshwar Mishra, for one, is optimistic that, within two to three years, India will be more attractive to manufacturers than China is. Rising labour costs in China will force them to look elsewhere.

India hopes to be, in a phrase often heard, “China 15 years ago”: on the point of becoming an export powerhouse. Hong Liang, an economist with Goldman Sachs in Hong Kong, says that, even in China, this idea is attracting attention. Policymakers have noticed, she says, that the emergence of China as a lower-cost competitor was a proximate cause of South-East Asia's financial crisis in 1997. Looking around for the source of such a threat to China, India is the obvious candidate.

As this survey has argued, India is not going to play that sort of role without radical change. Many think it will never happen, and argue that this does not matter: India is doing very well, growing faster and lifting more people out of poverty than ever, against a political and social backdrop immeasurably more complex than China's. The comparison is pointless; the two countries are just too different.

That may be true. But India needs to raise its growth rate not as part of some artificial race with China, but for its own sake. Because of its population profile, not to do so would bring a big rise in unemployment, with all the misery that implies. The obstacles are certainly daunting, and include some political reform. Elections in February in Bihar, India's most backward state, and the one where crime and politics have become least easily distinguished, served as a reminder of how difficult that will be in India's federal system. The growth of parties relying on particular lower-caste groups for their votes has led to unwieldy and often ugly coalition politics. But in a democracy, that is not a reason for making it harder for such parties to share power.

One consequence of this may be to widen the gap between the richest parts of India and those, like Bihar, that have been left behind. In both India and China, one of the big challenges of the next few years will be managing regional differences. Just six of India's 29 states attract almost all the foreign investment that comes into the country. China faces a comparable gap between its booming coastal provinces and the poorer interior. But its central government is better able both to dictate provincial policy and to invest in its backward western regions.

How the two countries cope with these and other social tensions will in part determine whether they can maintain or (for India) raise their present high rates of growth. China does not have the safety valve of regular competitive elections, but nor are there signs of an imminent explosion. India's political structure has shown itself well able to absorb all manner of shocks, but not, as yet, to achieve sustained radical growth-enhancing reform. Many would agree with Lord Desai's conclusion: “China will again become a viable Great Power; India may become just a Great Democracy.”

It is worth recalling, however, that when India launched its reforms, in 1991, the future of China's reforms was itself in doubt. After the Tiananmen protests in 1989, there was renewed infighting within the Communist Party about how far and how fast to push “reform and opening”. It was only Deng Xiaoping's “southern tour” in early 1992 that decided the debate conclusively in favour of a rush for growth.

India's position now is broadly similar. Economic reform has worked, as it did in China, but the country continues to face resistance from vested interests. Last year's election, seen as a rebuff to the politicians by the neglected rural poor, is sometimes interpreted as a vote against reform. But it was largely a vote against non-performing governments and, in that sense, a ringing call for more radical change. It showed that Indian voters understand the essential truth that Deng grasped about pre-reform China: “The old stuff didn't work.”